Conclusions and recommendations
Introduction
1. Whatever
the effect of the pubco model on competition, which we examine
later in this Report, the imbalance of bargaining power and information
between pubcos and their lessees has produced a system which is
biased against lessees, and needs to be examined in depth. Accordingly
this Report examines the industry from first principles rather
than being, as we first expected, a simple check on the implementation
of the Trade and Industry Committee's recommendations. (Paragraph
12)
Pub closures
2. It
is clear that figures for pub closures do not adequately cover
cases where individual lessees go out of business without the
pub itself actually closing. We cannot be confident that pubco
lessees are less likely to fail than other publicans. (Paragraph
35)
Rent assessment
3. Lessees
must appreciate that if a chartered surveyor is involved in their
rent negotiation he or she is acting on behalf of a client and
that is a legitimate role. However membership of a chartered
institution is no longer considered an automatic guarantee of
integrity and certainly not of impartiality; RICS members called
on to act in arbitration should be aware of the sensitivity of
their situation and must be scrupulous in declaring their interests.
(Paragraph 41)
Transparency
4. Given
the inherent subjectivity of the rental valuation method, it is
very important that there is transparency about the assumptions
on which it has been calculated. We note that there is disagreement
between lessee representatives and pubcos over whether the Trade
and Industry Committee's recommendation that "Pubcos should
provide their tenants with a comprehensive breakdown of how their
rent was calculated" has been implemented. The evidence
that this recommendation has not been fully implemented is confirmed
by our survey results which show that 44% of lessees had not been
shown a breakdown of how their rent was calculated. This is unacceptable.
(Paragraph 45)
5. We note that, without
transparency, rental calculations are open to manipulation by
the pubcos, in particular by systematically underestimating the
costs for a lessee of running their pub. We recommend that there
should be industry guidelines on the average costs of running
a pub such as those in the ALMR benchmarking survey. These can
be used by lessees as comparators against the rental assessments
put forward by their pubco. (Paragraph 47)
Trading history
6. We
accept that in many cases pubcos do not have access to their lessees'
books. However, they have access to a substantial amount of information
about the business of a particular pub, and are likely to have
extensive information if a business is in difficulties. Pubcos
entering a commercial relationship with a new lessee should be
required to share all their information on a pub's trading history
with them. (Paragraph 54)
Comparables
7. A
system must be put in place to allow lessees to assess whether
their rent is fair and in line with similar businesses. Our predecessor's
recommendation to create a register of rent reviews would have
increased transparency. We note it has been disregarded, and neither
the pubcos nor RICS has taken any serious action to make sure
the rental system is not unfairly biased against the lessee.
(Paragraph 58)
A new valuation method?
8. The
rental valuation method for pubs appears to be the product of
history and tradition. If it is to be fair, there must be far
greater transparency about how rents are calculated to ensure
equality between the parties to the negotiations. If this is
not improved as a matter of urgency, there are compelling arguments
for abandoning the method entirely. (Paragraph 60)
Rent reviews
9. It
is difficult to measure the extent to which trade has increased
because of improvements to the premises funded by the lessee.
Nonetheless, we consider it is manifestly unfair for pubcos to
profit from increases in trade brought about by such changes;
here, too, transparency on how rent is calculated and access to
figures for comparable premises would properly strengthen the
lessee's negotiating position. (Paragraph 70)
10. Our witnesses
are divided over the merits of annual RPI rental adjustments.
The pubcos claim this prevents lessees having to deal with a large
increase in the five yearly rent review; lessees consider it a
way of gradually increasing pubcos' share of the profits, and
of reducing pubcos' share of the risk. The evidence is finely
balanced, and we are not the appropriate body to resolve the question.
Two things are clear; firstly, pubcos' greater bargaining power
has enabled them in at least some cases to insist that upward
only rent reviews are replaced by annual rental adjustments in
line with RPI; secondly, if rental is linked to RPI it should
be done in a way which enables reductions when appropriate. (Paragraph
75)
The beer tie
11. The
effect of the beer tie on basic rent is that both pubco and lessee
take a lower income. However, while the decrease in the lessee's
income is absolute, the pubco has £110 from that part of
the discount on its barrelage it has not passed on to the lessee.
The reduction in rent is accompanied by a reduction in the lessee's
profit but an increase in the pubco's overall revenue. (Paragraph
84)
12. If the interests
of the pubcos operating a tied system and their lessees were truly
aligned, one would expect that pubcos would want a system in which
the combination of rental costs and beer costs enabled their lessees
to supply beer at a price which was competitive with other pubs.
This does not seem to be the case. (Paragraph 87)
Purchasing power
13. We
believe it is seriously misleading for any pubco to promote to
potential lessees that a pubco has benefits from 'purchasing power'
when that benefit is not passed on to lessees. (Paragraph 92)
Enforcing the tie
14. It
is entirely legitimate for a company to seek to ensure that the
other party to a contract respects its terms. However, we believe
that where a measurement device is used to police this, it should
be properly calibrated, and subject to external verification.
If necessary, the Weights and Measures Act 1985 should be amended
to ensure this. Furthermore, given the impossibility of distinguishing
between beer dispensed and sold, beer run off and disposed of
preparatory to serving, and water used to clean the lines, we
believe pubcos should not be allowed to rely on data from Brulines
equipment to enforce claims against lessees accused of buying
outside the tie. (Paragraph 98)
AWP tie
15. In
2004 the Trade and Industry Committee concluded that "In
our opinion, pubcos do not add sufficient extra value from their
deals to justify their claims to 50 percent of the takings from
AWP machines. We remain unconvinced that the benefits of the AWP
machine tie outweigh the income tenants forgo and we recommend
that the AWP machine tie be removed." That conclusion remains
valid. (Paragraph 103)
Insurance
16. Pubcos
have a right to require that each of their pubs is fully and properly
insured. It may well be that the insurance offered through pubcos
is as good as or better than any that lessees could arrange directly.
Nonetheless, since lessees are frequently not allowed sight of
the policy, it is impossible to establish whether this is the
case. Moreover, it is also clear that some insurance policies
require the lessees to pay for a benefit to the pubco. We do not
see why pubcos should not themselves take out insurance against
the risks they face directly. (Paragraph 108)
Benefits of the pubco tied model
17. We
conclude that pubcos may offer a lower cost route into the industry
and the opportunity for a lessee to create or maintain an asset
in the assignment value of the lease. However, this benefit is
accompanied by uncertainty about the value of the asset which
a lessee is purchasing, and the extent to which that value can
be maintained. While those who purchase a freehold property may
face higher initial outgoings, they obtain a tangible asset. Purchasers
of freehold leases have greater commercial freedom. (Paragraph
114)
18. Moreover
the attraction of low cost entry should not be overstated: a very
significant majority of those who responded to our survey said
they were attracted by a particular pub, not a particular business
model. Lessees apparently often choose tied pubs simply because
they are what are available in their preferred location, or because
they are attracted to a particular pub. That would mean that pubcos
were, by virtue of their large estates, diminishing competition
by forcing those who wish to run pubs into their business model.
(Paragraph 115)
Business support
19. The
Trade and Industry Committee found that "the performance
of business development managers (BDMs) varied across the industry
from excellent to dire." That conclusion remains valid. The
evidence we have received suggests that there are still too many
BDMs who offer lessees little or no support, and some who bully
or intimidate them. Moreover, some of our evidence suggests that
this culture is not limited to BDMs but can reach further up a
company. (Paragraph 120)
Financial Assistance
20. It
is surprising that the link between financial assistance and the
extension of the tie was not made clear in oral evidence. Financial
assistance which is offset by an increase in rental or an extension
of the tie is, in effect, 'repayable' and does not confer the
benefit claimed by the pubcos. (Paragraph 125)
21. We accept that
pubcos are helping their lessees with financial assistance but
there are many lessees who appear to be eligible for aid but do
not receive it. Pubcos need to make their policies on the administration
of financial help clear with a fair and open application process
for such assistance. Lessees need to know on what grounds they
are turned down. (Paragraph 128)
22. The Trade and
Industry Committee found that, on the evidence presented to them,
the immediately quantifiable cost of the tie was usually balanced
by the benefits available to tenants. From the evidence we have
received, we are not so convinced. We are particularly struck
by the results of our survey which found that 63% of lessees did
not think their pubco added any value. The pubcos offer little
support that cannot be found by normal market methods. (Paragraph
129)
A fair share of profits?
23. Increasing
a pub's turnover will benefit the pubco as it increases the sale
of tied products. To our surprise it does not seem to benefit
the lessee to nearly the same extent. Over 50% of the lessees
whose pubs had turnover of more than £500,000 a year earned
less than £15,000. The pubcos may share the risks with their
lessees but they do not share the benefits equitably. (Paragraph
133)
Lessees' attitude to the tie
24. The
dispute over the tie could be ended easily: every lessee could
be offered the choice of being free or being tied. This would
enable both sides to prove their competing claims. We believe
each and every existing lessee should, in a phased programme,
be offered this choice and the same choice should be offered to
every new lessee as he or she takes on the lease. To make the
choice fair, the process of agreeing revised rents must first
be improved as we have previously recommended. (Paragraph 138)
25. Although a voluntary
agreement is preferable, we doubt that the pubcos would respond
effectively to such an approach. We therefore recommend that the
Department considers how best to achieve this end and that it
opens an urgent consultation into the principle and phasing of
this proposal. The status quo is not an option. (Paragraph 139)
Dispute resolution
26. The
small number of cases pursued to independent arbitration should
not be taken as a sign that all is well. It could simply demonstrate
that, even though they were dissatisfied, lessees did not consider
the dispute resolution system appropriate. (Paragraph 142)
27. We agree that
some form of low-cost independent procedure for dealing with disputes
over the rate of rent is needed and needed urgently. The BII's
proposed dispute resolution system in which fees will be known
at the outset, and will be related to rental value is, in principle,
welcome. We would be more confident in the prospects for the successful
implementation of the BII's proposal if the Trade and Industry
Committee had not recommended precisely such a procedure over
four years ago. We are astounded that nothing has yet been done.
(Paragraph 149)
Legal remedies
28. The
BBPA's Framework Code of Practice and the recommendations of the
Trade and Industry Committee have not solved the problems of inequality
in bargaining power and inadequate means to resolve disputes identified
in 2004: we believe that more is now needed. (Paragraph 156)
29. Our inquiry has
inevitably attracted evidence from dissatisfied lessees. We have
tried to counter that by being as open as possible to the pubcos,
and by commissioning our own survey. We note that in our survey
results some pubcos fared better than others. It is clear from
our evidence that some lessees act recklessly, or enter into business
without due diligence. That is not the pubcos' failing. Nonetheless,
the pubco model should be based on a share of risk and reward.
That may be the case in some circumstances, but the two parties
to the contract have vastly differing bargaining power. The financial
data from our survey suggests that for a great many lessees, the
risk remains with them while the lion's share of the profit goes
to the pubco. We are not saying that all, or even any, pubcos
abuse all lessees all the time, but it is clear that not only
is there potential for abuse, but also that abuse occurs. (Paragraph
157)
30. Consumers are
protected from unequal bargaining power by the unfair contract
terms legislation. The law assumes that both parties to a business
contract have equal resources and expertise. This is clearly
not the case here — but if a pubco tried to enforce its
contract through legal proceedings, courts would be very reluctant
to determine whether those contract terms were fair because of
the presumption that commercial contracts are made between equals.
We recommend that the Department for Business and Enterprise
urgently explore ways of ensuring that there are safeguards to
prevent inequalities of bargaining power in business contracts
being abused. (Paragraph 158)
Competition Issues
31. We
believe it is for the market to decide whether a pub is unviable
and not for a pubco to restrict a building's use. We therefore
recommend that the Government makes the use of restrictive covenants
to prevent the continued use of premises as a pub illegal. (Paragraph
176)
32. We believe that
the supply ties operated by pubcos may well be anti-competitive
and may have a detrimental effect on the public house market.
We are disappointed that the OFT has failed to act on this matter
in the past and has refused to acknowledge the current problems
in the market. Since the OFT is unwilling to initiate an appropriate
investigation, we recommend that the Secretary of State uses powers
set out in section 159 of the Enterprise Act 2002 to refer supply
ties in the public house industry to the Competition Commission
for a market investigation. Given its clearly stated position,
we do not believe an OFT investigation would be satisfactory.
(Paragraph 190)
33. Our provisional
view is that the tying of beers, other drinks and ancillary products
should be severely limited to ensure that competition in the retail
market is restored. However, we note that interventions can have
unexpected consequences. The Beer Orders led to the emergence
of pubcos, simply replacing one group of powerful players with
another. Displacing pubcos without considering the market as a
whole may put too much power into the hands of brewers and wholesalers.
The position of local brewers operating a small tied estate also
needs to be considered; we would not wish to damage regional brewers.
For these reasons we are calling for an urgent investigation rather
than making a policy recommendation. (Paragraph 191)
Conclusion
34. This
Report contains recommendations which will affect the way in which
businesses can treat one another. Some might argue that this can
be left to the market. Pubcos which not only benefit themselves
but support their lessees are likely to stay in business. If pubcos
push too hard and are too greedy they will fail. But on the way
bad companies will inflict real damage on their direct customers,
the lessees, and on their indirect customers, ordinary drinkers.
(Paragraph 193)
35. It may be the
industry's problems can be solved by a framework ensuring fairness
and transparency in dealings between landlord and lessee. It may
be necessary to ensure that inequalities in bargaining power are
recognised, even when business contracts are involved. It may
be that the beer tie should be prohibited. The OFT has failed
to examine this market properly; the Government should now assume
responsibility, to ensure both that competition issues are properly
investigated and that the wider legal framework is adequate. (Paragraph
194)
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